Stephen Bainbridge's Journal of Law, Politics, and Culture

October 2010

10/31/2010

It's sort of sad, but I get almost as much pleasure out of a Dallas Cowboy loss as I do a Washington Redskin win. So this thought for the day made me very happy:

With the Cowboys showing no signs of pulling their season out of the toilet, the Cowboys are turning into a great fantasy matchup.

When the inconsistent Jaguars can waltz in and have QB David Garrard and WR Mike Sims-Walker post career-best numbers -- a week after the Giants dropped 41 points on Dallas -– you can lose any trepidation about starting anybody against Dallas.

Expect the Green Bay Packers to crank up their offense next week. And Dallas' remaining schedule includes plenty of powerful offenses, including a Week 10 rematch against the Giants, two games against the Eagles and matchups against Indianapolis and New Orleans.

A 1-15 season begins to look like a real possibility. And then Jerry Jones has to host the Super Bowl. What fun.

A stir recently erupted in the securities class action bar after Baer issued an order in a case against Gildan Activewear Inc., directing two of the largest firms in the field, Labaton Sucharow and Robbins Geller Rudman & Dowd, to "make every effort" to put at least one woman and one minority lawyer on the case. The ensuing press about the order caused Edward Labaton, a senior partner at his firm, to make a rare court appearance earlier this month to publicly state that his firm was committed to equal opportunity (See Labaton's letter to Baer).

In a follow up order last Friday in In re Gildan Activewear Inc. Securities Litigation, 08 cv 5048, Baer said his initial order "was not intended to be critical in any way" of how the two firms promote diversity or prosecute and staff a case. But he said the diversity considerations "were goals I would urge be met in similar cases that come before me."

The judge is basically saying that if you don't meet my quota, you may not be appointed as lead counsel in a securities case.

Under the the Private Securities Litigation Reform Act of 1995 (“PSLRA”),the court hearing a securities class action is empowered to appoint a lead plaintiff and to approve the lead plaintiff’s selection of lead counsel. The idea was to avoid having the class action lead by whatever plaintiff and his lawyer won the race to the courthouse.

The statutory language is pretty sparse: 15 USC § 78u-4(a)(3)(B)(v) simply provides that “The most adequate plaintiff shall, subject to the approval of the court, select and retain counsel to represent the class.”

Despite this statutory ambiguity, I don't see how Baer's order is consistent with the intent of the PSLRA lead plaintiff and lead counsel provisions. Those provisions were not intended to serve as a vehicle for affirmative action quotas or promoting diversity among law firms. Instead, they were intended to deal with the problem that it was the plaintiff's lawyer who was (and still is) the real party in interest in securities class actions. At the same time, however, the court's discretion in approving lead counsel is limited. The Ninth Circuit observed in Cohen v. U.S. Dist. Court for Northern Dist. of California, 586 F.3d 703 (9th Cir 2009) that:

Consistent with congressional intent in enacting the PSLRA to vest authority for selecting class counsel in the lead plaintiff and our reasoning in Cavanaugh, the district court should not reject a lead plaintiff's proposed counsel merely because it would have chosen differently. See306 F.3d at 732, 734 & n. 14 (explaining that selection of lead counsel “is not a beauty contest,” that selection of counsel is an “important client prerogative,” and that a contrary rule would “eviscerate” the PSLRA's assumption that the lead plaintiff is as or more capable than the court to select class counsel) (quoting Cendant, 264 F.3d at 276). Rather, like the Third Circuit, we hold that if the lead plaintiff has made a reasonable choice of counsel, the district court should generally defer to that choice.

Hence, imposition of an affirmative action quota-or even a preference--is not justified by the statutory language or its purpose.

If Rule 23(g) really did authorize a judge to take account of the race (or gender) of lawyers in certifying class counsel, the Rule would likely be unconstitutional. There is only one context in which the Supreme Court has held that, consistent with the Constitution’s equal protection requirements, the government may take account of an individual’s race in order to promote diversity: admission of students to universities. Grutter v. Bollinger (2003), involving a challenge to affirmative action at the University of Michigan Law School, held that government is allowed to pursue the compelling interest in obtaining the educational benefits that flow from a diverse university student body through an admissions process, geared to promoting multiple forms of diversity, that takes account of an applicant’s race as part of a holistic review of the applicant’s file.

Class action litigation is not higher education. It is difficult to see how government would have a compelling interest (or even an important interest, the standard for gender classifications) in promoting diversity among the lawyers appointed to represent a class of litigants. Even if ensuring some level of performance by class action lawyers is a compelling (or important) government interest (rather than just a rational interest), such an interest has little or nothing to do with the demographic characteristics of the lawyers themselves.

(Consider also the desirability of federal judges looking up lawyers on websites to determine--like the train conductors in Plessy v. Ferguson--their race and gender.)

In the New York Law Journal interview, Judge Baer invoked an additional reason for his approach: giving members of racial minority groups and women greater courtroom experience. It is equally doubtful that that’s an interest that rises to the level of a compelling (or important) government interest and there are surely ways for the government to pursue any such interest besides the use of a lawyer’s race (or gender).

Mazzone goes on to note that Baer's logic undermines the central justification for Grutter:

If the claim about broad educational benefits made to the Court in Grutter was correct, then there should be no need under Rule 23(g) to ensure class action lawyers match the racial and other characteristics of the class members. Lawyers who have been trained in a Grutter-endorsed law school should already have the requisite skills to understand, interact with, and properly represent people unlike themselves. The whole point of Grutter was to enable law schools to ensure its graduates have these qualities. On the other hand, if, as Judge Baer reasons, lawyers do not have these qualities, then the key justification for consideration of race by law school admissions offices vanishes.

10/29/2010

This eminently age worthy Merlot was still in fine fettle when opened tonight. I always worry about the plastic corks B&H used to use, which I believe are the least desirable of all the stopper alternatives, but this wine showed no sign of either oxidation or anaerobic off flavors. Instead, it was a clean wine with some oomph. Deep dark red and black fruits, especially currants and prunes. Some cedar and tobacco. Delicious. Could probably continue to develop for several more years before peaking. Grade: B++

10/28/2010

I was recently asked to write up a brief summary of the corporate governance provisions of the Dodd-Frank Act. The result has now been posted to SSRN. It's not a think piece, but folks looking for a quick overview of the Act's requirements and a concise critique thereof may find it useful:

Abstract: This essay provides a brief overview of the seven principal corporate governance provisions of The Wall Street Reform and Consumer Protection Act of 2010 (better known as “The Dodd-Frank Act”).

5. Section 971 affirms that the SEC has authority to promulgate a so-called “proxy access” rule pursuant to which shareholders would be allowed to use the company’s proxy statement to nominate candidates to the board of directors.

6. Section 972 requires that companies disclose whether the same person holds both the CEO and Chairman of the Board positions and why they either do or do not do so.

7. Section 989G affords small issuers an exemption from the internal controls auditor attestation requirement of Section 404(b) of the Sarbanes-Oxley Act.

Larry Ribstein offers a number of reasons to abstain, of which this is my favorite:

Gordon Tullock, in the inimitable style I recognize from being officed down the hall from him back at GMU (HT Café Hayek):

People are under delusions as to the importance of their vote. . . You’re more likely to be killed on the way to the polling booth than that you will change the outcome. . . . I don’t vote because I know there’s no likelihood my vote will affect the outcome. . . . If nobody else votes, I vote.

Appropriately weighty principles guide our course. First, we recognize that police power draws from the credo that "the needs of the many outweigh the needs of the few." Second, while this maxim rings utilitarian and Dickensian (not to mention Vulcan), it is cabined by something contrarian and Texan: distrust of intrusive government and a belief that police power is justified only by urgency, not expediency. ...

See STAR TREK II: THE WRATH OF KHAN (Paramount Pictures 1982). The film references several works of classic literature, none more prominently than A Tale of Two Cities. Spock gives Admiral Kirk an antique copy as a birthday present, and the film itself is bookended with the book's opening and closing passages. Most memorable, of course, is Spock's famous line from his moment of sacrifice: "Don't grieve, Admiral. It is logical. The needs of the many outweigh . . ." to which Kirk replies, "the needs of the few."

An article published in the Journal of Politics looked at 2,000 subjects from the National Longitudinal Study of Adolescent Health, examining their genes, social networks, and political affiliations. What they found was that adolescents who possess a certain variant of the dopamine receptor gene DRD4 were more likely to grow up to be liberal adults. Furthermore, that correlation only existed when adolescents had active social lives.

Remember I was a biophysical inorganic chemist before I was a lawyer, so I know of what I speak on these matters.

This is the story of what Rudyard Kipling called 'the savage wars of peace'. Throughout Queen Victoria's long reign there was not a single year in which, somewhere in the world, British soldiers were not fighting for her and her Empire. It tells the fascinating story of the little known and extraordinary small wars, and of the men who fought them.

These wars were the price on Empire, of world leadership and of national pride, and it was usually paid without qualms or regret; continuous warfare became an accepted way of life in the Victorian era, and in the process, the British Empire quadrupled in size. But, engrossing as these small wars are - and they bristle with bizarre, tragic and humorous incident - it is the officers and men who fought them that dominate the book. With their courage, foolhardiness and eccentricities, they are an unforgettable lot.

In it, we learn that just as the Afghans frustrated the Soviets, they did the same to the Victorian British.

While always protesting friendship, the British repeatedly invaded [Afghanistan] and shot at its inhabitants. Always unable to subdue the proud, fiercely independent Afghans, [they kept trying for fear Russia or Persia would]. (4-5)

[The campaign of 1880] proved once more that the British could defeat the Afghans in open battle but they could not hold the country. (216)

... the Afghans had a disconcerting habit of not knowing when they were defeated... (201)

Sorry for the headline. I couldn't help myself. Anyway, latest polling data indicates that support for Proposition 19's proposal to legalize marijuana is falling. I still think it's got a good chance of passage, however. As Tom Smith observes:

I suspect some who tell pollsters they'll vote no or don't know, will get in the booth and think, my mortgage, my credit cards, my F*&%ing job; I could use a little dope. This is just a theory.

Meanwhile, Carly Fiorina and Meg Whitman also trail. The thought of 4 years of Jerry Brown and 6 more of Barbara Boxer is making me green around the gills. As usual, I'll probably have to depend on national news for anything cheerful on election night.

Proponents of institutional investor activism constantly tell us that activists will not micro-manage their portfolio companies. Well, that's just total bullsh*t. Case in point:

Activist investors are turning up the heat on companies that give relocating executives generous benefits to cover the cost of their depressed home values. ...

The root problem: The protracted housing downturn in the U.S. is colliding with a rebound in management hiring. So more employers help pick up the tab for relocated executives losing money on their home sales.

Home-loss provisions are a hot-button issue with our institutional clients," explains Patrick McGurn, special counsel for ISS. "We have been seeing extraordinary relocation payments being made to bail out transferred executives."

In the first place, isn't the point of executive compensation to attract and retain competent executives? If relocation reimbursements help do that, isn't that a good thing?

Proponents defend the perk as necessary for businesses to attract and keep star players. "They simply need those executives to move," says James D.C. Barrall, head of the global executive compensation and benefits practice at Latham & Watkins LLP.

In the second place, isn't what really matters not specific items of pay but rather the total effect of pay has on executive incentives? Marty Robins writes that:

I’m a lot more concerned with management and board performance, as it translates into company performance, than I am with pay per se. To the extent pay is relevant, this should be on account of either its overall incentive effects regarding performance or whether it has any connection to “market value” for the position in question. Simply protesting this (or any individual) item of someone’s pay package has nothing to do with company performance. It makes no sense to address any individual line item for someone, without addressing their aggregate pay and assessing its implications and level.

Money being fungible makes it pointless and counterproductive to protest reimbursement for a home sale loss, if the beneficiary’s overall package is well structured for incentive purposes and in line with the market. If a corresponding increase in salary or bonus would not prompt shareholder protest, why should a protest result from the name of the payment? Similarly, if there is good reason to protest total compensation, the rationale still exists, notwithstanding the formal designation of a portion of it. Good performance relative to total pay should not lose its luster because of a home sale provision … and vice versa!

Finally, self-appointed shareholder spokespersons like Lucian Bebchuk, Nell Minow, Robert Monks, and their ilk have told us over and over that their institutional clients will not seek to micromanage portfolio firms. And now we see that that's bullsh*t. If picking nits like home relocation reimbursement isn't micromanagement, I don't know what is.

Dodd-Frank Section 953 requires that each reporting company’s annual proxy statement must contain a clear exposition of the relationship between executive compensation and the issuer’s financial performance. The disclosure must give investors an easy way of comparing executive compensation and firm performance over time. The proxy statement also must disclose whether employees are allowed to hedge the value of company stock they own.

Companies include equity in a compensation package to align the interests of management with those of shareholders. It is not uncommon for an executive who has been employed at a company for many years to accumulate a substantial dollar ownership position in the company. With a concentration of wealth in a single financial asset, the executive may want to limit his or her exposure by hedging a portion of the position through financial instruments or pledging shares as collateral for a loan.

While there are many reasons why a board may want to allow an executive to hedge or pledge an equity ownership position, there are also many reasons why this may be a cause for concern. We examine these issues in detail.

Can boards explain why they do or do not allow executive hedging? If an executive has hedged the equity position, why does the board continue to grant new equity and not cash?

The Closer Look series is a collection of short case studies through which we explore topics, issues, and controversies in corporate governance. In each study, we take a targeted look at a specific issue that is relevant to the current debate on governance and explain why it is so important. These free instructional materials may be used in the classroom and by practitioners who want to develop a more sophisticated understanding of governance practices.

Even though the materials are designed for a business school case study, I think they'd be useful to law professors wanting to address hedging and executive compensation.

10/26/2010

Towers Watson launched an online survey tool to help companies better understand their shareholders’ views and perceptions on their executive compensation programs.

Dodd-Frank requires publicly traded companies to conduct periodic shareholder votes on their executive pay programs, including how often to conduct say-on-pay votes. In preparation for the say-on-pay era, many companies are trying to engage their key shareholders in a dialogue about executive compensation and related issues. According to Eric Larré, a Towers Watson consulting director who spearheaded the survey’s development:

For most U.S. companies, giving shareholders a say on pay will be a new experience when the 2011 proxy season arrives. And most companies are still trying to determine how to address the shareholder engagement process. This survey offers shareholders an easy way to express specific views that Congress and the SEC determined they were entitled to communicate via the proxy process.

The Towers Watson online survey tool allows shareholders to complete a questionnaire and provide their views on a wide range of executive compensation programs and issues including pay philosophy, performance measurement, pay levels, governance and shareholder preferences regarding the frequency of future say-on-pay votes. The questionnaire consists of both multiple-choice and open-ended questions. Companies receive a detailed report summarizing shareholders’ responses, including an analysis of differing views of shareholders and what percentage of all company shareholders the respondents represent.

Obviously, on line surveys are hopelessly unscientific and replete with problems of all sorts. Even so,one can imagine companies using this to (a) take a pre-check of shareholder sentiment before the say on pay vote and (b) to have data on what shareholders want when activists come calling. Suppose a union pension fund comes to management and says we don't X, Y, and Z about your compensation policies, so we're going to vote no. Management may be able to point to support for retain investors to justify the union demands.

I came to the study of law because it seemed like a good career for someone who loved reading, writing, and analyzing texts but was not creative enough to make it as a novelist nor independently wealthy enough to risk becoming a medievalist.

Goodness. If you tossed in sucked at math too much to be a theoretical scientist or economist and was too butter fingered to be an experimental scientist, you'd have an almost exact description of how I came to law.

It turned out okay, of course. Indeed, I suspect I make a good deal more money than 99.99% of the science fiction writers I wanted to emulate when I was a kid or the historian I briefly toyed with being. Plus, it's been fun.